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Opinions of Friday, 7 January 2011

Columnist: Adam, Mohammed Amin

No Cheap Oil Anymore

Between Realistic Petroleum Prices and Petropolitics In Ghana

by
Mohammed Amin Adam

tabat15@yahoo.com

INTRODUCTION

Frequent adjustments to petroleum prices in Ghana are not strange to anyone in the country. What becomes a bone of contention is the level of adjustments. Due to the asymmetric relationship between crude oil prices and ex-pump prices, it is not usual to see downward adjustments in domestic prices even in times of lower crude oil prices. There are more upward adjustments in prices. Excuses such as using the over-recovery to pay debts or subsidize prices are usually blamed for this. This means that petroleum pricing must make economic sense. The most recent announcement of 30% upward adjustments in ex-pump prices in Ghana should therefore be a reality call on all Ghanaians to rise above the era of ‘petropolitics’ which has never provided solution to our oil price management. No government in Ghana can ignore the economic reality behind price adjustments in favour of political considerations. This may prove very costly politically though, yet the cost to the economy may even be worse, undermining short-term and long-term economic sustainability.

POLICY CHANGE
Since the introduction of the deregulation policy in the petroleum sector, petroleum pricing policy has changed significantly. Cost recovery and removal of government funded subsidy underlined the policy shift. However, due to the unprecedented rise in crude price to about $147 per barrel of oil, subsidies were re-introduced. In particular diesel, kerosene, premix and LPG were subsidized with petrol most of the time cross-subsidizing the others. However, the current ex-pump prices show that the subsidy policy has been reviewed.
Diesel and engine oil subsidies were meant to reduce the impact of price adjustment on transport fares and cost of business because these products are mainly consumed by commercial transport operators and industrial machinery. The change in the policy can be seen in terms of the higher current price for diesel relative to petrol (1.18 pesewas per litre of diesel against 1.16 pesewas per litre of petrol). Thus diesel is no longer subsidized, hence the higher transport fares announced by commercial vehicle operators.
Also, LPG prices were subsidized for environmental reasons, that is, to reduce dependence on wood-fuel as a source of energy for domestic use and thereby discourage deforestation of Ghana’s fast depleting forest reserves. The removal of significant portion of subsidy on LPG is another shift in policy. This might be due to the increasing commercial use of LPG by vehicle operators and therefore the validity of domestic use of LPG for cooking is no longer tenable.
What the managers of the economy needs now is policy consistency. It therefore requires the support and understanding of Ghanaians to hold government accountable for any policy inconsistency and thereby reduce uncertainties that usually accompany fuel price adjustments, which often have serious implications for the economy. Frequent changes in the energy policy apparently for political reasons certainly do not help the country.

NO CHEAP OIL ANY MORE
There is no cheap conventional oil any longer. For the past decade, global crude oil output has hovered between 62 million barrels per day and 65 million barrels except in 2006 when it reached 67 million barrels before falling to 65 million barrels and remained there. At the same time upstream investments are not matching up with global supply requirement due to increasing global capital shortage, rising cost of oil rigs, storage facilities, pipelines and skilled manpower. Costs of upstream investments are generally rising. According to the World Oil Outlook, upstream cost and average worldwide unit of capital for additional new supply of oil per barrel and gas has more than doubled since 2000 with as much as 76% of the increase occurring in the last three years. The search for new oil deep off-shore, which promises global oil security, has also become very expensive and requiring huge investments capital. Ghana’s jubilee phase 1 project for instance, producing only 500 million barrels in twenty years, cost almost US$4 billion.
In the midst of these supply challenges, global demand for oil is ever increasing and likely to increase further as a result of the global economic recovery led by Asia and now Latin America in addition. Most of the developed countries who are also major consumers of oil are not able to reduce their over-reliance on oil. In 2010, the US oil import bill jumped by US$72 billion while Japan spent additional US$27 billion. Even less developed countries saw their oil import bill rose by US$20 billion in the same period. These factors will keep crude oil prices higher. According to the International Energy Agency (IEA), crude oil prices are likely to remain above US$90 per barrel of oil and if this happens, the ratio of oil import bills to GDP will be at levels close to that of the global financial crisis era in 2008. Countries are therefore bracing up to the phenomenon of high oil prices and Ghana cannot be an exception.

PETROPOLITICS AND ECONOMIC REALITY
The coincidence between the fuel price hikes and first lifting of crude oil from the jubilee fields should alert us that there will not be cheap oil in Ghana. Fact is, Ghana will buy its own oil at the prevailing market crude price. This is not different from other oil producing countries that import the bulk of their oil for domestic consumption and examples such as Nigeria and the United States of America are there for reference. This perhaps is the time for Ghanaians to eschew ‘petropolitics’ and see petroleum issues as economic reality.
There is no doubt that the price hikes will increase the cost of living index, cost of doing business, transport fares and thereby introduce inflationary pressures. But why will a government whose monetary policy is inflation targeting increase fuel prices which has implications for raising inflation? The answer is not farfetched. The cost of subsidizing petroleum prices by government to the economy as a whole no doubt is higher than the cost to inflation. The problem of Tema Oil Refinery debts which nearly collapsed the Ghana Commercial Bank and threatened the country’s ability to raise letters of credit for crude oil import is one of such costs Ghanaians are still paying.
It is also true that the political economy cost of fuel price hikes could undermine economic development especially when disposable incomes are reduced and aggregate demand falls as a result; when the hardships imposed on the people lead to social and political tensions which could threaten national stability and adversely affects investments attractions; and when governments that are pursuing good economic programmes become unpopular and lose elections.
There is therefore the need to balance economics with political reality. This should however not be in the form of government absorption of prices or subsidies. Rather the balance should reflect in the social and economic mitigation policies which should be introduced to ameliorate the effects of price hikes whiles contributing to social and economic development. In the past, social mitigation policies such as mass transport, capitation grants, national health insurance, etc were introduced to minimize the effects of price hikes. Even though, these policies have been continued with, they need serious review. Especially the policy on mass transport and rail transport systems must be improved not just to provide cheaper transport to the population but also for the purpose of energy conservation.
In fact, what government needed to do before the fuel price hikes was to cut costs in the price components they have control over and allow only efficient margins in the price build up. Unfortunately, the costs of these components such as distribution and marketing margins, were increased, and thus allowing the inefficiencies of these distributors to be transferred to consumers. What due diligence was conducted on these institutions to justify the increase in their cost margins is certainly not known to the public.

PRICE STABILIZATION IS THE ANSWER
Policies such as energy diversification and conservation have been introduced in some countries, but they may not be easy for developing countries who have less resources to implement them. It is certain that most countries including Ghana have no control over crude oil prices which constitutes the largest component in the price build up. The most sustainable way of mitigating the impact of oil price hikes on the economy and the population is therefore to pursue price stabilization policies.
Hedging is one of the price stabilization policies which have been tried in Ghana. The government entered into hedging in October 2009 because it anticipated the ever increasing prices of crude oil. However, one is not able to tell the effect of this hedge on the current ex-pump prices. The problem with Ghana’s hedging model is the cost associated with it. The insurance premium which the country pays on its hedge might be the reason the current prices have not been affected by the hedge. The maturity period is also due in March 2011. It therefore remains to be seen what changes will reflect in petroleum prices when the hedge matures.
The following price stabilization policies should be explored in addition to hedging to ensure that higher crude oil prices do not dislocate domestic price stability.
Fuel Price Stabilization Fund: This is in line with the concept of the Social Mitigation Levy which was part of the fuel price build up until 2009 and from which social interventions such as the mass transport busses were financed. However, with the price stabilization fund, the proceeds will be used to stabilize domestic oil prices by financing part of the oil bill and absorb part of the price hikes. In this case, consumers are subsidizing their own consumption through a front-loaded payment. This saves the government from using resources for development to finance price subsidies.
The fund which will be invested can only be disbursed under some strict conditions to ensure that it is not dissipated. We need a benchmark crude price level beyond which the funds can be disbursed. For instance, it can be disbursed only when crude oil prices increase by more than 10%. If the increase is below 10% the funds will not be disbursed, since domestic price adjustments will not be significant. The fund should be established by an Act of Parliament and the accounts independently managed to prevent diversion of its proceeds to other activities.
Oil Stock Management: Stock levels in Ghana have been influenced by strategic reserve arguments. As a result the level of reserves over the years has been low. We therefore need to see reserve stocks as price stabilization instrument. In this case, when crude prices are higher, the country’s stocks of oil could be released into the market to stabilize domestic price, the same way as we are doing with the buffer stock company in the case of food stuffs. In deed US oil stocks have become an important determinant of crude oil prices as well as US prices. This is why domestic prices in the US have been relatively stable. Government must invest in reserve stock capacity and also encourage the private sector to invest in this venture in order to increase the stocks levels beyond what the Bulk Oil Storage Company (BOST) can accommodate. Thus, our deregulation policy must be expanded to cover private oil stock management similar to the bonded warehousing concept.
The problem with maintaining stocks is the costs involved including the insurance cover, and who bears them. Fortunately, there is a BOST levy in our domestic price build up. This levy should be increased if possible to increase investments in reserve capacity and to accommodate the high cost of maintaining stocks in private sector facilities especially during periods of low crude prices. A higher BOST levy could raise petroleum prices in the short-run but this could become a price stabilizer in the medium to long-run when we are able to build more storage facilities and build up more stocks.
As an oil producing country, we need to buy more of our crude oil into stocks, which could also be traded to our neighbours during higher crude prices to make more profits. The advantage of buying our own crude in to stock is that we avoid payments for costs, insurance and freights (cif), which usually increase the price of imported crude.

CONCLUSION
Ghanaians must realize that the political rhetoric surrounding fuel prices no longer has room in our energy policy. ‘Petropolitics’ will head our country to economic difficulties. We must study the global market phenomenon and come to terms that cheap oil is no longer available. Major producing countries like Iran and Nigeria have moved towards economic pricing. We must therefore not give in to political parties to carry all of us along the dangerous path of self-destruction. As Ghana goes to elections in 2012 Ghanaians must know that oil prices do not know NDC and NPP, two major political parties in Ghana. We therefore need a national energy pricing policy that transcends political parties. I have offered some solutions above which may be costly in the short run but which could provide answers to our quest for fuel price stabilization in the medium to long-run period.